Arizona Court of Appeals Division Two holds that the Arizona Corporation Commission’s approval of a rate plan that decreased but did not eliminate subsidies among customer classes was not arbitrary, unlawful, or unsupported by substantial evidence.

The Arizona Corporation Commission is created by the Arizona Constitution and empowered to regulate public service companies including by prescribing “just and reasonable” classifications, rates, and charges for utility companies. Ariz. Const. art. XV, § 3. Arizona courts conduct only limited constitutional review of this near plenary authority. A party challenging the Commission’s actions must “demonstrate, clearly and convincingly, that the Commission’s decision is arbitrary, unlawful or unsupported by substantial evidence.” Litchfield Park Serv. Co. v. Ariz. Corp. Comm’n, 178 Ariz. 431, 434 (App. 1994).

The Commission hears rate cases in which it adopts or approves the rates that utilities can charge their customers. During a rate case, the Commission calculates a “revenue requirement,” which requires determining the percentage of return on investment that the utility will receive under the new rates. There is also a Class Cost of Service Study which determines the costs of providing service to each customer class including the residential and various commercial classes. In this case, no one challenged the findings of the Class Cost of Service Study or the aggregate 6.57% rate of return.

The issue in this case was how the revenue requirement was allocated between the classes. In general, classes pay (or receive) subsidies when the utility charges a rate of return that is higher (or lower) than the aggregate rate. Everyone involved in this rate case proposed class rates which decreased but did not eliminate the pre-existing subsidies between the classes. The Commission adopted a hybrid of those proposals, in which the residential class paid a rate of return of only 0.94% while some of the commercial classes paid as much as 10.94% and 21.33%.

Freeport Minerals Group appealed to the Court of Appeals, arguing that the rate plan was not “just and reasonable” because it did not do enough to reduce subsidies. The Court of Appeals held that in utility ratemaking, the “gradualism” policy followed by the Commission here is well-recognized and generally accepted by both experts and courts in other states. Gradualism is designed to adjust rates in stages over time to avoid “rate shock.” Here, the complete elimination of subsidies would have increased residential utility rates by roughly twenty-five percent. Under the adopted plan Freeport’s rates increased by approximately 1.7 %, while residential rates increased by approximately 12.6 %. This effectively cut by half the subsidy received by the residential class. The Court of Appeals cannot substitute its judgment of an optimal rate structure for that of the Commission and therefore the Court affirmed the Commission.